Fitch Ratings has affirmed Zambia's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'B' with Negative Outlook. The issue ratings on Zambia's long-term senior unsecured foreign- and local-currency bonds and short-term senior unsecured local-currency securities are also affirmed at 'B'. The Country Ceiling is affirmed at 'B+' and the Short-Term Foreign and Local Currency IDRs at 'B'.
KEY RATING DRIVERS
Zambia's 'B' IDRs reflect a combination of the country's persistent fiscal deficits, which have led to a doubling of the general government debt ratio over the past five years, and structural constraints that keep economic growth below potential. These weaknesses are balanced against an improving fiscal and external outlook, enhanced monetary policy credibility and the potential implementation of a fiscal and economic adjustment agenda, which is likely to be supported by the adoption of an IMF programme.
Under-performance in revenues, mostly related to the mining sector, and the weakness of expenditure controls have led Zambia to consistently overshoot its fiscal deficit targets. On a cash basis, the 2016 fiscal deficit is estimated at 5.5% of GDP, but the accumulation of new arrears, mostly related to road spending, pension contributions and fuel and power imports, pushed the deficit closer to 9% on a commitment basis.
Fitch forecasts the 2017 general government balance to narrow to 6.1% of GDP on a commitment basis. The tightening is mainly driven by no accumulation of new arrears (vs. an estimated 3.8% of GDP of new arrears in 2016). Fitch expects the authorities will also pay down some of the accumulated arrears (an estimated ZMW2.5 billion or 0.9% of GDP) which will widen the cash deficit to 7% of GDP. Going forward, the government's fiscal consolidation will be supported by fuel price adjustments made in October 2016, planned cuts in electricity subsidies, tighter expenditure control and an increase in revenues from the mining sector, which will see an expected increase of up to 10% in copper production.
Kwacha appreciation has helped to stabilise the debt/GDP ratio, but high debt servicing costs present a downside risk to fiscal consolidation. General government debt will increase to approximately 53% of GDP in 2017, from 48% at end-2016, which is below the 'B' median of 60%. However, Zambia's debt burden is more significant in light of the country's generally low levels of domestic revenue mobilisation. Debt as a percentage of revenue stands at 258% of GDP and interest payments at 19% of revenue, both well above the 'B' medians of 242% and 11% respectively.
Zambia has been in discussion with the IMF over a possible support programme since early 2016 and, despite the protracted nature of the discussions, Fitch expects that the authorities will reach agreement on a programme in 1H17. A programme would help to provide a policy anchor and would also unlock additional sources of external financing from multilateral and bilateral lenders at concessionary rates. The government has committed to an economic recovery programme that includes increasing domestic resource mobilisation, rationalising expenditures, and arresting the accumulation of new arrears. Fitch expects that all of these areas would be enshrined into an IMF programme. The Fund will return to Zambia in March to conduct Article IV consultations and to continue programme discussions.
Fitch forecasts GDP growth of 4% in 2017, an increase from 3.1% in 2016 but well below the 7% growth that Zambia averaged in the 10 years prior to 2016. Growth will be supported by increases in copper production at the Kalumbila, Kansanshi and Lubambe mines which, along with an increase in copper prices, will keep growth in the mining sector above 4%. Additionally, increasing rainfall will boost agricultural output and also aid the nation's strained power generation capacity. However, the country will continue to operate at a power deficit of roughly 200MW through 2017. A lack of transport infrastructure and an under-developed agricultural sector will remain a constraint on Zambia's growth potential.
An improving trade balance will help to keep the kwacha stable; Fitch expects a slight depreciation to approximately ZMW10.5 per USD. In addition, the monetary policy tightening undertaken by the Bank of Zambia (BOZ) in 2015 and early 2016 will help keep inflation in single-digits. Fuel and electricity price adjustments will lead to some inflationary pressure.
BOZ has already begun to undertake some monetary loosening through adjusting reserve ratios and lifting previous restrictions on overnight lending. Fitch expects a lowering of the monetary policy rate some time in 1H17. However, more substantial monetary loosening is unlikely until the government has established the credibility of its fiscal policy adjustments.
The severe tightening of domestic liquidity conditions that started in late 2015 and the weakening of the economy led to a rise in non-performing loans to 9.7% last year from 6% in 2014. Liquidity has improved as the currency has stabilised and as BOZ unwinds some of its interbank lending restrictions. The Zambian banking sector is generally well-capitalised and well-supervised by the central bank.
Fitch forecasts the current account deficit to narrow to 2.1% of GDP in 2017, after having widened to 4.8% in 2016. Zambia averaged a current account surplus of 3.8% of GDP in the years 2010-14, but low export receipts and increasing external debt servicing payments brought the current account into deficit in 2015. The stable kwacha will aid foreign exchange reserves accumulation, along with expected inflows of external financing, and should bring the international reserves position to USD2.5 billion, approximately 3.2 months of current external payments, by end-2017.
The high growth rates generated by the booming copper sector resulted in an improvement in social indicators, but per capita income (at 60% of the B median) and measures of human development remain weak compared with 'B' category peers. Health and education outcomes are especially weak, with an average life expectancy of 60 years. The lack of skills adversely affects the employability of the workforce, with only 10% employed in the formal sector.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Zambia a score equivalent to a rating of 'B-' on the Long-Term Foreign Currency IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign Currency IDR by applying its QO, relative to rated peers, as follows:
- Macro: +1 notch, to reflect BOZ's implementation of monetary policy, which supports macroeconomic stability and the expected implementation of the government's fiscal and structural reform agenda, which is expected to be supported by an IMF programme.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year-centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
The main factors that could, individually, or collectively, lead to the ratings being downgraded include:
- A sustained inability to access external sources of financing, as might occur with the failure to successfully negotiate an IMF programme, and which could lead to liquidity and funding shortfalls;
- A failure to reverse fiscal deterioration and stabilise the government debt ratio;
- Further deterioration in external balances, for example through a sharp and sustained fall in copper prices, relative to Fitch's forecast.
The main factors that could, individually, or collectively, lead to the Outlook being revised to Stable include:
- The successful implementation of an economic reform programme that leads to sustained higher growth;
- Effective fiscal consolidation that leads to a sustained narrowing of the fiscal deficit and stabilisation of the general government debt ratio;
- A rise in international reserve coverage, thereby reducing Zambia's vulnerability to external shocks.
Fitch expects that the authorities will come to agreement with the IMF on a lending support programme that contributes additional external financing.
Fitch assumes a gradual increase in copper prices over the medium term.